A father deeds his house to his son before death. The son is to sell the house and divide proceeds among the five children. The house sells for 250,000 but half is lost to the son's girlfriend. However, the son only admits to having 50,000 now, several months since the sale. Each beneficiary will get 10,000 in a round about way of receiving their inheritance. How will each be effected by taxes? Will the son have to pay gift tax on the 50,000 or will it be considered tax-free inheritance for all involved? Oh yeah, there was no final return filed for deceased father (he passed in January '06).

There are several problems here. First, by transferring the deed prior to his death, the father made a gift to the son, His estate owes gift tax. This will also affect the tax basis of the property.

Second, once the house is transferred there is nothing to legally compel the son to distriute the proceeds.

But if all that is left is $50K to be distributed 5 ways, then this is under the gift tax threshold so the son doesn't have to worry about gift taxes.

a father deeds his house to his son before death
This is gift from father to son. Father must file gift tax return

the son is to sell the house... the house sells for 250,000.
Must report profit from sale on schedule D. However, if he owned the house for two years and lived in the house for two years, he can exclude gain of up to S250,000.

the house sells for 250,000 but half is lost to the son's girlfriend.
This is not deductible.

however, the son only admits to having 50,000 now, several months since the sale. each beneficiary will get 10,000 in a round about way of receiving their inheritance.
This is not inheritance. This is gifting. A gift of $10,000 to any individual is below the gift exemption limit. So there is no filing requirement.

All the above comments are accurate, but here is some clarification:

While a gift tax return IS required, no gift taxes are due because the giver can access the $2 million estate exclusion.

If this is an actual real-life case and not a scenario, the tax advisor to the father should retire and NEVER give tax advice again. There was absolutely NO tax advantage to deeding the house to the son, because it is apparent that the father's estate is WELL BELOW the estate tax threshold of $2 million.